The risk-free rate on T-bills recently was 1.23%

The risk-free rate on T-bills recently was 1.23%

Subject: Business    / Finance   
Question
Chapter 6
Warm-up questions 2.2

E6-1
The risk-free rate on T-bills recently was 1.23%. If the real rate of interest is estimated to be 0.80%, what was the expected level of inflation?

E6-2
The yields for Treasuries with differing maturities on a recent day were as shown in the table on p.253.

a.    Use the information to plot a yield curve for this date.
b.    If the expectation hypothesis is true, approximately what rate of return do investors expect a 5 year Treasury not to pay 5 years from now.

Maturity——————Yield
3 months —————–1.41%
6 months——————1.71%
2 years———————2.68%
3 years———————3.01%
5 years———————3.70%
10 years——————–4.51%
30 years——————–5.25%

c.    If the expectations hypothesis is true, approximately (ignoring compounding) what rate of return do investors expect a 1 year Treasury security to pay starting 2 years from now?
d.    Is it possible that even though the yield curve slopes up in this problem, investors do not expect rising interest rates? Explain.

E6-3
The yields for Treasuries with differing maturities, including an estimate of the real rate of interest, on recent day were as shown in the following table:

Maturity———–Yield————-Real rate of interest
3 months———-1.41%—————0.80%
6 months———–1.71%————–0.80
2 years————–2.68%————–0.80
3 years————–3.01%————–0.80
5 year—————3.70%————–0.80
10 year————–4.51%————–0.80
30 year————–5.25%————–0.80

Use the information in the proceeding table to calculate the inflation expectation for each maturity.

E6-4
Recently, the annual inflation rate measured by the Consumer Price Index (CPI) was forecast to be 3.3%. How could it have had a zero real rate of return? What minimum rate of return must the T-bill have earned to meet your requirement of a 2% real rate of return?

E6-5
Calculate the risk premium for each of the following rating classes of long-term securities, assuming that the yield to maturity (YTM) for comparable Treasuries is 4.51%.

Rating class———-Normal interest rate
AAA——————–5.12%
BBB———————5.78%
B————————–7.82%

E6-6
You have two assets and must calculate their values today base on their different payment streams and appropriate required returns. Asset 1 has a required return of 1.5% and will produce a stream of $500 at the end of each year indefinitely. Asset 2 has a required return of 10% and will produce an end-of-year cash flow of $1,200 in the first year, $1,500 in the second year, and $850 in its third and final year.

E6-7
A bond with 5 year Treasury bond has a coupon rate of 4.5%.

a. Give examples of required rates of the return that would make the bond sell at a discount, at a premium, and a par.
b. If the bond’s par value is $10,000, calculate the differing values for this bond given the required rates you chose in part a.